The interbank cost of borrowing dollars for three months fell, snapping five days of increases, as money markets hoped that a Federal Reserve statement on Wednesday would offer more evidence that the Fed was trying to ease financial market strains and help the economy recover.
The Fed is expected to keep the key fed funds rate near zero and repeat its vow to keep rates low as it takes other steps to crank up credit markets and ease a global recession.
"Today's FOMC statement can offer nothing to the front end of the curve that we didn't get from the December statement, but the Fed could enhance its jawboning vis a vis the potential to buy long-term Treasuries," said David Ader, US government bond strategist at RBS Greenwich Capital in Greenwich, Connecticut.
Goldman Sachs chief US economist Jan Hatzius said it was "highly likely" that the Fed would eventually decide to buy longer-term Treasury securities because "even a zero percent nominal federal funds rate is likely to look much too high by 2010, so the Federal Open Market Committee (FOMC) will need to look for alternative means of easing financial conditions and boosting economic activity."
In addition, since the Fed raised the prospect of Treasury purchases in December, it "will find it difficult not to follow through eventually," said Hatzius, who works in New York. But Hatzius said it was uncertain whether the Fed was ready to announce actual purchases on Wednesday. Near-term, the FOMC could just maintain its mantra that it is still "evaluating the potential benefits" of purchasing Treasuries. Strategists said purchases of long-dated Treasuries would likely lead to lower Libor rates, though there would be little immediate effect.
Fed purchases of long-dated Treasuries and other similar strategies won't "do the trick on its own," said BNP Paribas rate strategist Matteo Regesta, who noted the most immediate problems concern bank balance sheets and interbank lending.
Three-month dollar Libor rates fell a basis point to 1.17438 percent, but the dollar Libor/OIS spread - which expresses the three-month premium paid over anticipated central bank rates and reflects banks' willingness to lend to each other - barely budged, holding around 95 basis points.
Three-month sterling Libor rates rose, albeit marginally, for the first time since early October, with traders saying the rate could flatten off now until there were signs that the Bank of England is ready to cut rates below 1 percent.
In New York, three-month borrowing rates for US banks were 1.2180 percent on January 28, according to ICAP's New York Funding Rate. ICAP's 3-month NYFR was 1.2180 percent versus the previous session's 1.2290 percent, ICAP said. ICAP's one-month NYFR 0.4550 percent versus the previous session's 0.4470 percent. That compares with a one-month dollar-denominated Libor rate last fixed at 0.40938 percent.
In Europe, the ECB lent 43.239 billion euros - less than many in the market had expected - in its latest fixed-rate three-month operation that will cover the crucial quarter-end period where banks must balance their books.
One trader said the lower-than-expected amount, coupled with fewer bidders at Tuesday's one-week auction, might reflect banks' confidence that they can meet reserve requirements without any problems. Elsewhere, government efforts to stabilise the financial industry continued. Austria on Tuesday initiated an aid package to stabilise the emerging European banking sector.
Australia's government planned a second economic stimulus and round of tax cuts. In the United States, the commercial paper market faces an important test of the success of the Commercial Paper Funding Facility (CPFF) this week. Morgan Stanley estimates that $145 billion of the $351 billion of 90-day commercial paper taken by the Fed matures this week and another $98 billion next week.